Steve Bucci has been helping people decode and master personal finance issues for more than 20 years. He is the author of “Credit Management Kit For Dummies,” “Credit Repair Kit For Dummies,” “Barnes and Noble Debt Management,” co-author of “Managing Your Money All-In-One For Dummies” and “Debt Repair Kit For Dummies” (Australia). Steve is an experienced expert witness in identity theft, credit scoring and debt related cases. He has been a presenter at the FICO InterACT Global Conference, the Federal Reserve and the International Credit Symposium at Cambridge University in the UK.
How does a student loan deferment affect your credit score?
A student loan in deferment does not affect your credit score because it’s not a currently due obligation. If your score dropped after your loan came out of deferment, it’s likely that something negative has happened, such as a missed payment, high credit card account utilization or a credit report error.
Dear Keeping Score,
Hello, I had a student loan that just came out of deferment so I decided to make my monthly payments because I’m now able to afford the payment. “Student loan – payment deferred” was removed from the account and the payment I made was updated on the account, but my TransUnion score dropped 43 points and Equifax dropped 81. Can you provide some feedback why this happened, please? Thank you. -Juliet
First off, congratulations on getting to the next step in getting out of debt by paying off your student loan. Student loan debt in this country is approaching $1.6 trillion, so knowing there are responsible grads like you out there who are ready to start paying off their loans gives me hope for the future.
However, I can hear the frustration in your question because you are doing the right thing here. Why are you being dinged for being responsible? Is it true that no good deed goes unpunished?
It helps to understand what credit scoring is and how it works. So here goes:
A credit score looks at your current obligations and tries to predict if you are likely to default on your payments going forward. Until now, your deferred loan was not a currently due obligation, so it didn’t factor into your score.
Sixty-five percent of your score is based on how much you owe and how you are repaying your debt. How much you currently owe is the credit utilization piece of the credit scoring pie worth 30 percent, second only to payment history at 35 percent in importance to your score. An account in deferment means you have put off repaying your debt until a future date and therefore it has no bearing on your score one way or the other.
Tip: How do you build credit with a student loan? A FICO score only requires that a credit report show one credit account that was opened at least six months ago and one account last reported to the credit bureaus within the past six months. With a student loan being paid on time, there’s no need to carry a credit card just to establish credit.
So, what accounts for the downward spiral in your scores? It seems likely that something else has happened. For instance, you may have missed a payment on another account or your credit card balances may have reached a high utilization threshold. Another possibility is that there is an error appearing your credit report, such as a delinquent account owned by someone with a name similar to yours. In any case, you should check your credit report (you can get a free copy at AnnualCreditReport.com).
Anything negative like that would likely cause a substantial drop in score like the one you saw. But why did your TransUnion score fall by a different amount from your Equifax generated score? Since each credit bureau has different information about you in their files, the impact of credit report items – including negative marks – may vary by reporting agency. This may account for the differences between your scores.
Use autopay and an emergency fund to stay on top of your loan payments
Since your loan is now out of deferment, it’s critical to make your payments on time from now on to avoid further credit score damage. The key going forward for you is to establish a stellar repayment pattern. But you need to be prepared and know that this will take some time and diligence. You mentioned that you began to make your payments because you could now afford them. Going forward, you are obligated to make all your loan payments even when it is difficult to do so.
What you think you can afford doesn’t matter. The most important thing for you to do will be to make your student loan payments on time every single month. If this means setting up automatic payments, that might be the way to go. In fact, some loan servicers will knock off a few points from your interest rate if you will go that route.
Since the standard repayment term for federal student loans is 10 years and private loan terms can be five to 20 years, even a few points off of your interest rate could make a huge difference to how much you pay in the end.
Auto payments will ensure that you are never late, but you have to be certain that the funds are always available on your due date. If not, you will likely face a late fee and you risk having the account reported as late. You do not want this to happen, because the point is to never miss a due date. And no one wants to pay a late fee! My favorite way to make sure the money is always available is to set up an emergency fund.
Budgeting for unforeseen emergencies is critical because of the unpredictability of life events. Without emergency savings, something as minor as a car repair can cause a monthly budget deficit that has to be filled from somewhere else in your budget, like missing or reducing a payment!
Having an emergency stash on hand if something happens will be essential to making sure you have sufficient funds to make all of your payments in a timely manner.
Remember to keep track of your score!